On prend la température

29 novembre 2019

Chris Iggo , CIO Core Investments

The consensus expectation is for flat line growth in the major economies. Investor expectation is that, short term, things get better. The problem is that current valuations and long-term growth are not exciting. Demographics might mean that there is so much savings money chasing ever fewer investment opportunities, at least in public markets, returns will be low. The one big theme that can change that is climate. Yet there is no clear road map. Governments have to take a lead in accelerating carbon transition. Investors will follow and allocate capital accordingly. That is the big theme. In the meantime…we still need to invest according to the economic cycle.

Meh meh meh…

It continues to be a strange cycle. As many market participants publish their year-ahead outlooks the consensus seems to be that the expansion will extend further. I have not seen anything forecasting an outright recession in 2020 although, along with the proliferation of base-case scenarios, the alternative with the biggest weighting is the downside one. While growth is forecasting to be a little better, largely because of a first half bounce from the trade-fear induced slowdown in 2019, the trend rate of growth is still low. A non-linear evolution of risk could certainly be in the outlook if there is any kind of new shock to growth in the quarters ahead, especially as many economies will be operating at levels not much above “stall-speed”. For example, of the US were to slip below the 1.6% growth rate that our economics team are currently forecasting, then a quick increase in unemployment could result, triggering a cut-back in consumer and corporate spending. Investor sentiment, at this juncture, is very much dependent on risks to growth not materialising.

Big sigh

Indeed, over the last few months investor sentiment has come back from the brink. Recession fears a year ago forced the US Federal Reserve (Fed) into an abrupt change in its monetary stance. The escalation of trade fears and tariffs was the key concern for corporates and investors alike and those fears were confirmed by the weakness in global manufacturing activity. The US ISM peaked in August 2018 at a level of 60.8 – indicating very strong growth in the US manufacturing sector – and has subsequently fallen to a recent low in September of 48.3 – indicating a modest contraction in activity. In recent weeks, however, sentiment has improved and the data has stabilised. As we enter an election year in the US there is an expectation of a trade deal between the US and China and the headline of getting a deal done will be, temporarily, more important for markets than the details and the fact that the US-China relationship will continue to be a source of global tensions. Similarly, the headline chances of “getting Brexit done” have improved and that is having some positive impact on markets, even though it would only mark the beginning of a more important process of trying to get a trade deal with the EU done in the next year or so. If the preliminary meetings between UK and US trade officials on a potential trade deal between the two countries generated a 451-page document (brandished around in the election debate over the last week) can you imagine what the size will be of a new UK-EU agreement that will have to address customs, tariffs and regulatory alignment. But that is for consideration later. For the moment investor sentiment is better, cash has been put into markets in recent months, and returns across the board are better than many would have imagined a year ago.

Between the holidays

No-one should discount what can happen in December. Generally it is a month of risk-on where equity returns are positive. Since the Great Financial Crisis, last year was the worst December performance for the S&P500. Unless there is some surprising economic data or a real risk of some turmoil in US politics as the impeachment process gets sent to the House Judiciary Committee, the market does not seem set up for a big downdraft. In the absence of a big market shock, that will leave us with fairly generous valuations across most liquid asset markets. Our expectation is that bond returns will be much lower in 2020 than in 2019. For equities, there will be a little more optimism on earnings, but ratings are already higher. Having said that, from a pure tactical asset allocation point of view, the preference is to be overweight equities going into the new year.

No change in rates

What we do know about next year is the following. Interest rates will remain low. The ups and downs of the market will continue to be dominated by politics. Some investors will look for the Fed to keep cutting rates. Others will look for opportunities to get better returns than on offer in the bond markets where yields are low. That dynamic itself will create some potential market risks. If there is economic weakness then investors will question what central banks have left in their locker. If the conclusion is not very much, then the attention will be much more focussed on fiscal policy.

Look for cheapness

So focus on value. In bonds, short duration or flexible strategies are best suited to the current environment. A passive exposure to rates or duration could mean unwanted volatility. Limiting duration and having the ability to navigate between rates and credit risk is probably the best way to navigate the bond markets in the next year. On the equity side the focus should be on long-term growth.

Are we already seeing climate issues impact?

We should also watch dispersion in markets. CCC-rated bonds in US high yield have underperformed. The equity and auto sector have underperformed in many markets. Is that the “invisible hand” already punishing sectors at the centre of the carbon transition debate? Investors may already be underweighting sectors and companies within sectors, that are not expected to deliver value over the long-term. This is a trend certainly worth watching. The CCC-rated energy bonds account for about 2.5% of the US high yield market but are contributing 20% of the yield. Interesting? Warning sign? Justification for more aggressive ESG policies? Probably all three. It is clear to me that climate change is central to policy thinking – even in the financial sector. Over time, investors will get better returns from having better (particularly) climate targets for their portfolios. In June next year, the UK will host COP26. The focus in the investment community will be one what more can be done to support carbon transition. In a world where traditional metrics of performance are going to be subdued, the ability to demonstrate progress in how we allocate capital towards climate change goals will be super-important.

Goals

I have not addressed football recently. The Premier League seems to be Liverpool’s for the taking. Manchester City are the closest rivals. Leicester City are the more popular rivals. Man. United and Arsenal are shadows of their former selves. Jose Mourinho is back, at Tottenham this time. At least he won’t have to live in a hotel this time. Whatever happened with him at United, I still like him. Not as a manager necessarily, but as a character in our game. Spurs are well placed with their great stadium. But what fans want it more adventurous football. Where are the 6-4 games? Where is the swashbuckling teams of Kevin Keegan? Where are the strikers like Van Persie, Cole, Sheringham, Phillips, Henry and Wright? I’ve never been a fan of Pep’s tippy-tappy because when it goes wrong his teams turn. Maybe UEFA/FIFA should make it 4 points for a goal.

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